The year 2004 is now officially ended. While the markets performed pretty close to expectations there were a few surprises. Interest rates rose far less that expected, the economy showed fairly robust growth in spite of high oil prices, and concerns over an uncertain Presidential election proved to be overblown. On the other hand, certain expectations were met in 2004. The Federal Reserve did begin its predicted move to tighten, consumers continued to spend freely, and market volatility remained high, with the bulk of the year’s returns coming in November and December. The overall market performance in 2004 illustrates perfectly two truisms of investing; you can’t predict the returns in the short run and you seldom benefit from trying to time the market.

One of the biggest impediments to successful investing is the natural tendency we all have to get too defensive when stocks are down and too aggressive when stocks are up. It was very tempting to scale out of the market as stocks slid in the third quarter. Fears of rising oil prices, a potentially contentious Presidential election and expectations of rapidly rising interest rates all seemed to support a more conservative stance, at least for the short term. Unfortunately, those who acted on that prediction lost out because the market subsequently rallied sharply in the fourth quarter, posting substantial returns. Chances are by the time an investor realized the rally was truly underway it was too late to fully participate.

The fundamental mistake in this scenario is allowing yourself to change your risk tolerance in response to a short run market expectation. When establishing an appropriate risk tolerance you should consider you overall financial capacity, the amount of time until you anticipate needing the assets, other risks to your financial "health", and your willingness to weather price volatility. Notice that concern for near term market performance is not a consideration so to adjust your portfolio in expectation of a short term movement in the markets is to effectively ignore the legitimate considerations you used in setting your overall risk tolerance. What may seem on the surface to be a conservative approach is really nothing more than a form of market speculation.

If your overall risk tolerance suggests exposure to stocks then maintain that exposure, don’t try to second guess your plans. While the short term results may make you uncomfortable from time to time, in the long run you’ll almost always be far ahead of the game. Decisions on the appropriate risk tolerance for you are best made on a basis of your financial and life situation, not the current market outlook. Never loose sight of the main goal, to maximize the total amount of assets available to you at the time you need them. Whatever happens between now and then is not very important.

As always, please feel free to contact me if you have any questions.

Randy Gridley